Solvency ratios are used to measure a company’s ability to stay in business for a long period of time. While liquidity is looking at the current situation, solvency is looking at the long-term situation.
One common solvency ratio:
Debt to Total Asset Ratio
The formula for Debt to Total Assets Ratio is:
Debt to Total Asset Ratio = Total Liabilities / Total Assets
Debt to Total Asset Ratio is used to examine the company’s long-term ability to meet obligations. Debt-financing is risky for any business as obligations have to be paid on a particular date in time. To utilize the formula take into consideration all liabilities whether short-term or long-term. For assets add up all the assets less depreciation that the company owns.
Long-term debts are any debts that the company has that will be paid at some time in the future beyond the current year or operating cycle.
Interpreting results: Higher ratios means the company has less equity. With a high ratio most of the assets are being financed with debt which in turn lowers the cushion that creditors have to collect on those liabilities.
